'No-load' Annuities Attract Interest

HUMBERTO CRUZ FUND WATCH

September 10, 2000|HUMBERTO CRUZ COLUMNIST

I get at least half a dozen letters a week from readers who own variable annuities and tell the same tale:

They invested in one even if they did not really understand it -- the broker just made the annuity sound great. The returns have been disappointing, and they suspect the annuity's high annual expenses are at least partly to blame. But if they take their money out, they will get hit with stiff surrender charges. They realize now these charges are spelled out in the annuity contract but don't remember the broker saying anything about them.

I admit, that's a terribly unfair portrayal of variable annuities and brokers. After all, people who are happy with their annuities -- that includes me -- would have no reason to write.

Still, variable annuities have come under scrutiny by securities regulators who worry that the high annual expenses and sometimes-lengthy surrender charges are not always properly explained to investors. This spring the Securities and Exchange Commission posted an online brochure, "Variable Annuities: What You Should Know" at its Web site, www.sec.gov/consumer/varannty.htm, warning investors about these drawbacks.

But things are getting better -- a lot better. Without fanfare, low-cost annuities that charge no up-front commissions and no surrender charges are multiplying. Some have been available for years through no-load mutual fund and discount brokerage firms, and others, clones of more expensive broker-sold annuities, are now being marketed online.

As investors catch on, these "no-load" annuities may become as popular as no-load mutual funds.

"That's the way we see it," said Gregory G. Yost, chairman and CEO of AnnuityScout.com, an online annuity shopping service that surveys annuity offerings by 55 companies and lists what it considers the best.

Here, I ought to pause and explain. Variable annuities, which are sold by life insurance companies, are tax-deferred investments with a just a tiny bit of insurance.

The investor usually has a choice of different "subaccounts" that are similar to mutual funds. The money grows tax-deferred until withdrawn, when all gains are taxed as ordinary income. Also, withdrawals before age 591/2 usually incur a 10 percent penalty.

The insurance part is twofold. The insurance company guarantees that if you die before you start taking your money out, the person you name as beneficiary will receive at least the amount you invested.

It also guarantees that, if you so choose, you can withdraw your money as a series of monthly payments that will last as long as you live.

You may not care about these features -- I don't, and many financial planners question their value -- but without this insurance component, the investments could not qualify for tax deferral under our tax code.

These insurance features also make variable annuities costlier than mutual funds. Many charge 1.4 percent a year or more, money you may not realize you are paying because it is taken out of the value of your account, for these so-called "mortality and expense" charges.

The people who sell annuities don't tell you, but these charges also help pay for their commissions. Surrender charges -- penalizing you if you bail out of an annuity before a certain time is up, often seven years or more -- also help to cover insurance costs and compensate brokers.

But by using the power and reach of the Internet to slash distribution costs, the lower-cost, more investor-friendly annuities are doing away with surrender charges and chipping away at annual expenses.

These lower costs are making annuities something you might actually want to buy if you have already put in the maximum in other tax-deferred plans.

"The cost of distribution on the Internet is one-tenth that of a traditional broker," said Yost, whose company recorded $10 million in annuity sales -- both variable and fixed, or those that pay a set rate of interest -- since the www.annuityscout.com Web site was launched in March.

That's still a drop in the bucket compared with the estimated $155 billion in annuity sales in the United States last year, a figure that could grow to $200 billion this year, according to industry estimates. Americans have about $1.6 trillion invested in annuities, 96 percent of them sold by brokers, Yost said.

"I am not against brokers; I am against people paying high fees when they don't have to," Yost said.

The AnnuityScout.com Web site, while offering excellent values, does not list the lowest-cost annuities in the business. That honor goes to TIAA-CREF (800-842-2776) and Vanguard (800-462-2391, or in New York state, 800-258-4271).

"They are absolutely the lowest cost," Yost readily acknowledged, "but they don't offer as many choices." Investment subaccounts in the TIAA-CREF and Vanguard annuities are limited to select funds from each firm.